Starting a business can be an exciting yet challenging endeavor. It’s important to understand that it might take some time and money before you start seeing any profits. From a tax perspective, you might be wondering how to handle the costs associated with starting and organizing your business.
The good news is that the entrepreneurial spirit is alive and well, even in the face of a pandemic. Data from the U.S. Census Bureau shows that new business formation is on the rise.
So, what exactly are start-up and organizational costs? Start-up costs are any expenses you incur while setting up your business or exploring the possibility of starting one. Organizational costs, on the other hand, are the expenses you incur while establishing a corporation or partnership.
Typically, these costs need to be capitalized, meaning they’re added to your balance sheet as an investment in your business. However, you can choose to deduct up to $5,000 of start-up and $5,000 of organizational costs in your first year of business. You don’t need any separate documents to do this.
But there’s a catch. If your total start-up or organizational costs exceed $50,000, the $5,000 cap is reduced. Any remaining costs must be spread out and deducted over 15 years. If your expenses are $55,000 or more, you can’t claim the $5,000 allowance at all.
You can claim the deduction for start-up costs in the year you start your business. This is usually when your business is ready to start making money. Some indicators that you’re in business include trying to sell your products or services, launching your website, or receiving a certificate of occupancy.
Not all costs can be treated as start-up or organizational costs. Deductible start-up costs are expenses that would have been deductible if they were incurred when the business was operational. These include costs for market analysis, advertising, rent, insurance, employee training, travel for securing prospective business partners, and professional fees.
Organizational costs include legal services, state incorporation fees, and costs for temporary directors and organizational meetings for corporations. However, corporations can’t treat expenses for issuing and selling stock or transferring assets as organizational costs. Similarly, partnerships can’t treat costs for acquiring and transferring assets, admitting new partners, or contracts between the partnership and its partners as organizational expenses.
Starting a business is a big step, and it’s advisable to work with a CPA or tax advisor to make sure you’re optimizing your deductions for start-up and organizational costs.
